Cash balance plans

Each year around this time, we can all see the inevitable not too far in the distance. Our tax liability — and how we manage it — is generally not as festive as the recently past holiday season. However, your retirement planning and the type of plan you establish can offer a reduction of tax liability and accelerated contributions to help produce additional income when you’ll need it most — at retirement after active work.

There are two general types of pension plans — defined-benefit plans and defined-contribution plans. In general, defined-benefit plans provide a specific benefit at retirement for each eligible employee, while defined-contribution plans specify the amount of contributions to be made by the employer toward an employee’s retirement account.

In a defined-contribution plan, the actual amount of retirement benefits provided to employees depends on the amount of their contributions, along with employer contributions such as Safe Harbor or profit-sharing contributions, as well as the gains or losses of the account over time.

Many of our dentist clients take advantage of this combination by “maxing” out the total allowable contributions, currently $53,000 if under age 50 or $59,000 if over age 50, while giving a needed ratio of contributions to eligible staff as well.

However, we often are asked, “What else can I do aside from after tax investing? What other types of retirement plans are available?”

Enter the cash balance plan, a type of defined-benefit plan that when paired with a 401k/profit-sharing plan provides an opportunity to essentially squeeze 20 years of saving into 10, while at the same time significantly reducing your tax liability along the way. As the chart accompanying this article shows, the benefits of the cash balance plan really start to accelerate as the business owner gets beyond age 45-50.

While employer matching and profit-sharing contributions are discretionary, cash balance plans require more of a commitment to fund the plan by the employer. Most plans are set up with a 3-5 year funding period, so they work well in environments where the business owner will have predictable income over that time frame.

Different from a 401k plan where participants generally choose their investment options, the assets of a cash balance plan are managed by the employer or an investment manager. In a typical cash balance plan, a participant’s account is credited each year with a “pay credit” (such as 5% of compensation from the employer) and an “interest credit” (either a fixed rate or a variable rate that is linked to an index such as the 1-year Treasury Bill rate).

To determine if a cash balance plan is right for you, enlist an actuary who is an expert in retirement plan design to analyze your practice demographics with a current census of full-time employees. If this plan design can meet your individual and corporate objectives, you have a far greater pool of income available when the time comes to hang up the white coat.